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The word debt carries a negative connotation, but people sometimes differentiate "good debt" from "bad debt." Debt that helps you acquire appreciating assets, like a house or a business, is generally considered good. Debt backed by collateral that you could sell if necessary, like a car, could be good or bad depending on the terms of the loan.
But there is one type of debt that seems to always be labeled bad — credit card debt. Here’s why that is.
While credit card debt can be "bad," credit cards themselves are not inherently bad. They're merely financial tools. Moreover, saying that credit card debt is "bad" is not a value judgment on the person carrying such debt. No one is "bad" for leaning on credit cards for, say, medical care or to put food on the table when they have no other options. "Bad debt" is debt that doesn't provide something of ongoing value to the person who owes it, whether that's a place to live, a car to drive or an education. "Bad" just means it's debt that's best avoided if possible and, if you have it, should be the first debt you work on paying off.
Credit card debt is typically the most expensive debt you can take on. Interest rates on credit cards are typically well into the double-digits and often above 20% — even for people with good credit. By contrast, the best interest rates on student loans, mortgages and personal loans can be well under 10%. This is why it's generally not recommended to put large expenses like medical debt on credit cards if you can avoid it. There may be much cheaper options available.
» MORE:Why are credit card interest rates so high?
2. The minimum payments will take you years to pay off the balance in full
If you want a good laugh — or scare — check out the "minimum payment warning" on your credit card statement. It tells you how many years and months it will take for you to pay off your credit card debt making only the minimum payment. Let’s say you have a balance of $8,000 on a credit card with 18% interest and a minimum payment of $160. If you make only the minimum monthly payment, you won’t pay off the credit card for seven years and seven months and you’ll pay $6,432 in interest.
If you choose to double your minimum payment and pay $320 a month, your debt will be wiped out in two years and seven months, and you’ll only accrue $1,912 in interest. Simply by doubling your payment, you’ll save five years and $4,520 in interest payments. If you have credit card debt, always pay much more than the minimum to save time and money.
» MORE: What happens if I make only the minimum payment on my credit card?
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“Good” debt is typically defined as mortgage, education or business debt because, ideally, each of these investments will generate returns for years to come.
Mortgage or real estate debt is generally most profitable for those who own rental properties, but there’s also a possibility of making money from your personal residence when you sell it. Education debt is supposed to help you get a job with a better salary than you would get with a high school diploma. And business debt can be a great investment if the business succeeds. Of course, every investment requires taking some risk, but calculated risk can result in large rewards.
Credit card debt isn’t used to buy appreciating assets. It may be used for depreciating purchases — like home furnishings, clothing items or gadgets — or consumables, such as food and gasoline. There's nothing wrong with any of these purchases, but paying interest on them is unnecessary and can raise their true prices significantly.
A good rule of thumb is to avoid going into debt purchasing things that won’t go up in value. Should you cut up all your credit cards? No, just don’t spend more on them than you can afford to pay in full each month before any interest accrues. Credit cards are a great tool when used correctly, but credit card debt is cripplingly expensive — so don’t carry it over from one month to the next if you can avoid it.
The bottom line: Credit card debt is considered "bad" debt because of its high interest rates and low minimum payments, and the fact that it isn’t used to buy appreciating assets. Use your credit cards for the rewards and other benefits, but pay the balance in full each month.
"Bad debt" is debt that doesn't provide something of ongoing value to the person who owes it, whether that's a place to live, a car to drive or an education. "Bad" just means it's debt that's best avoided if possible and, if you have it, should be the first debt you work on paying off.
Bad debt is when you use credit cards to purchase disposable items or durable goods and don't pay off the balance in full. A common example of creating bad debt is using a credit card to purchase clothes. Clothes are typically worth less than 50% of what you pay for them when you walk out of the store.
Credit cards can make it easy to get into debt. It's tempting to use them to buy things you can't afford, and if you don't pay your bill on time, your debt can quickly snowball. Owing too much on your credit card, and not making your payments on time are two mistakes that will seriously damage your credit score.
Credit card debt is a type of unsecured liability that is incurred through revolving credit card loans. Borrowers can accumulate credit card debt by opening numerous credit card accounts with varying terms and credit limits. All of a borrower's credit card accounts will be reported and tracked by credit bureaus.
These normally have high interest rates. High-interest credit cards - Some credit cards come with APRs above 25%. This makes it difficult for people to pay off their credit card bills, leading to an accumulation of costs.
The average American household now owes $7,951 in credit card debt, according to the most recent data available from the Federal Reserve Bank of New York and the U.S. Census Bureau.
It's generally recommended that you have two to three credit card accounts at a time, in addition to other types of credit. Remember that your total available credit and your debt to credit ratio can impact your credit scores. If you have more than three credit cards, it may be hard to keep track of monthly payments.
How many credit cards does the average person have? According to the latest figures from Experian, the average American has 3.84 credit cards with an average credit limit of $30,365.
Here's how most people get trapped in credit card debt: You use your card for a purchase you can't afford or want to defer payment, and then you make only the minimum payment that month. Soon, you are in the habit of using your card to purchase things beyond your budget.
How Many Americans Are Living Paycheck to Paycheck? A 2023 survey conducted by Payroll.org highlighted that 78% of Americans live paycheck to paycheck, a 6% increase from the previous year. In other words, more than three-quarters of Americans struggle to save or invest after paying for their monthly expenses.
Yes, you can qualify for a home loan and carry credit card debt at the same time. But before you start the homebuying process, you'll need to understand how credit card debt impacts your creditworthiness — this can help you decide whether it makes sense to pay down your credit card debt before buying a house.
In general, you never want your minimum credit card payments to exceed 10 percent of your net income. Net income is the amount of income you take home after taxes and other deductions. You use the net income for this ratio because that's the amount of income you have available to spend on bills and other expenses.
In the U.S., the average credit score is 716, per Experian's latest data from the second quarter of 2023. And when you break down the average credit score by age, the typical American is hovering near or above that score.
A DTI ratio is usually expressed as a percentage.This ratio includes all of your total recurring monthly debt — credit card balances, rent or mortgage payments, vehicle loans and more.
In general, you never want your minimum credit card payments to exceed 10 percent of your net income. Net income is the amount of income you take home after taxes and other deductions. You use the net income for this ratio because that's the amount of income you have available to spend on bills and other expenses.
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